An Operational Perspective on Microfinancing in Developing Countries

49 Pages Posted: 1 Feb 2023 Last revised: 11 Mar 2024

See all articles by Opher Baron

Opher Baron

University of Toronto - Rotman School of Management

Elaheh Rashidinejad

University of Toronto - Rotman School of Management

Gonzalo Romero

University of Toronto - Rotman School of Management

Date Written: January 28, 2023

Abstract

Close to 10% of the world's population lives in poverty. Microfinancing provides accessible credit to entrepreneurs at the Base of the Pyramid (BOP) and can potentially address this issue. However, many studies have shown the limited impact of microfinancing on reducing poverty due to profit motives and imperfect information of the lending institutions. To examine these issues, we study the effects of different microfinancing setups in developing countries on poverty through an operational lens.

We consider a Newsvendor with financing and effort framework. We assume that a BOP entrepreneur effort has a multiplicative effect on the random demand for her product. Furthermore, she starts with zero initial budget and borrows a loan to operate her business. The bank may face bankruptcy cost. We examine two relevant cases: First, a social bank that operates as an external lending institution and cannot collect the entire debt in the presence of business losses. Second, a community bank that consists of peers in a community gathering their savings to form a bank and using their social ties to collect the debt eventually. We study these banks under profit-maximizing or zero-profit objectives. We find that the effort exerted by the entrepreneur is the main driver of her utility in equilibrium. Further, the main determinants of the effectiveness of these microfinancing setups are the bankruptcy cost and the product's critical fractile. We establish conditions under which the zero-profit (profit-maximizing) community bank generates higher social welfare than the zero-profit (profit-maximizing) social bank. A numerical study confirms the robustness of our main analytical results and provides additional insights. For example, we discuss the importance of imperfect information on the critical fractile and its impact on the efficacy of the microfinancing setups we study.

Our work provides practical guidelines on how to improve the design of microfinancing structures to maximize social impact and help alleviate poverty in a financially sustainable fashion.

Keywords: Microfinance, Poverty, Sustainable Operations, Newvendor, Supply Chain Finance

Suggested Citation

Baron, Opher and Rashidinejad, Elaheh and Romero, Gonzalo, An Operational Perspective on Microfinancing in Developing Countries (January 28, 2023). Available at SSRN: https://ssrn.com/abstract=4340029 or http://dx.doi.org/10.2139/ssrn.4340029

Opher Baron

University of Toronto - Rotman School of Management ( email )

Elaheh Rashidinejad

University of Toronto - Rotman School of Management ( email )

Gonzalo Romero (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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